TYBFM Debt Mutual Fund: MD College

Understanding risk in Critical

Introduction

Objectives

Advantages & Disadvantages of Mutual Fund

History of Mutual Fund in India

Structure of Mutual Fund Industry

Categories of Mutual Fund

Debt Mutual Fund

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CHAPTER 1

INTRODUCTION TO MUTUAL FUND

Definition

SEBI (Mutual Fund) Regulations 1993 defines Mutual Fund as “a fund

established in the form of a trust by a sponsor to raise money by the trustees
through the sale of units to the public under one or more schemes for investing
securities in accordance with these regulations” The rationale behind a mutual
fund is that there a large number of investors who lack the time and or the
skills to manage their money.

Hence, professional fund managers, acting on behalf of the Mutual Fund,

manage the investments (investor’s money) for their benefit in return for a
management fee. The organization that manages the investment is called the
Asset Management Company (AMC). Thus, a Mutual Fund is the most
suitable investment for the common person as it offers an opportunity to invest
in a diversified, professionally managed basket of securities at a relatively low
cost. Anybody with an investible surplus of as little as a few thousand rupees
can invest in mutual fund .Each mutual fund scheme has defined investment
objective and strategy.

A Draft offer documents is to be prepared for launching a fund. Typically, it

specifies the investment objectives of the fund, the risk associated, the cost
involved in the process and the broad rules for entry into and exit from funds
and others areas of operation. As you probably know, mutual funds have
become extremely popular over the last couple of decades what was once just
another obscure instrument is now part of daily lives. More than 80 million
people or one half of the household in America invest in mutual funds. That
means that, in the United States alone, trillions of dollars alone are invested in

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mutual fund. In fact, too many people, investing means buying mutual funds
After all, its common knowledge that investing in mutual fund is (or at least
should be) better than simply letting cash waste away in a saving account but
for most people, that’s where the understanding of fund ends.

Mutual fund is a mechanism for pooling the resources by issuing unit to the
investors and investing funds in securities in accordance with the objective as
disclosed in offer document. Investment in securities is spread across a wide
section of industry and sector and the risk is reduced. Diversification reduces
the risk because all stock may or may not move in the same direction in the
same proportion to their proportion at the same time. Mutual fund issues units
to the investors in accordance with quantum of money invested by them.
Investor of mutual are called unit holders.The profit or losses are shared by the
investors in proportion to their investment. The mutual fund usually comes out
with a number of schemes with different investment objectives which are
launched from time to time. A mutual fund is required to be registered with
the SEBI, which regulates securities markets before it can collect fund from
the public.

A mutual fund is nothing more than a collective stock and /or bonds. You can
think of a mutual fund as a company that brings together a group of people
and invests their money in stock, bonds and other securities Each investors
owns shares which represent a portion of holding of the fund.

In India, SEBI (Mutual Fund) Regulations, 1996 regulates the structure of

mutual funds. Mutual funds in India are constituted in the form of a Public
Trust created under The Indian Trusts Act, 1882.

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INTRODUCTION TO MUTUAL FUND AND ITS VARIOUS

ASPECTS.

Mutual fund is a trust that pools the savings of a number of investors who
share a common financial goal. This pool of money is invested in accordance
with a stated objective. The joint ownership of the fund is thus “Mutual”, i.e.
the fund belongs to all investors. The money thus collected is then invested in
capital market instruments such as shares, debentures and other securities. The
income earned through these investments and the capital appreciations
realized are shared by its unit holders in proportion the number of units owned
by them. Thus a Mutual Fund is the most suitable investment for the common
man as it offers an opportunity to invest in a diversified, professionally
managed basket of securities at a relatively low cost. A Mutual Fund is an
investment tool that allows small investors access to a well-diversified
portfolio of equities, bonds and other securities. Each shareholder participates
in the gain or loss of the fund. Units are issued and can be redeemed as
needed. The funds Net Asset value (NAV) is determined each day.

Investments in securities are spread across a wide cross-section of industries

and sectors and thus the risk is reduced. Diversification reduces the risk
because all stocks may not move in the same direction in the same proportion
at the same time. Mutual fund issues units to the investors in accordance with
quantum of money invested by them. Investors of mutual funds are known as
unit holders.

When an investor subscribes for the units of a mutual fund, he becomes part
owner of the assets of the fund in the same proportion as his contribution
amount put up with the (the total amount of the fund). Mutual Fund investor

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is also known as a mutual fund shareholder or a unit holder.
Any change in the value of the investments made into capital market
instruments (such as shares, debentures etc) is reflected in the Net Asset Value
(NAV) of the scheme. NAV is defined as the market value of the Mutual Fund
scheme's assets net of its liabilities. NAV of a scheme is calculated by
dividing the market value of scheme's assets by the total number of units
issued to the investors.

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CHAPTER 2

OBJECTIVES

 To understand Mutual Fund in detail.

 To understand, analyze the various categories in Mutual Fund
especially Debt/ Income Mutual Fund.

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CHAPTER 3

ADVANTAGES & DISADVANTAGES OF MUTUAL FUND

ADVANTAGES OF MUTUAL FUND

 Portfolio Diversifications
 Professional management
 Reduction / Diversification of Risk
 Liquidity
 Flexibility & Convenience
 Reduction in Transaction cost
 Safety of regulated environment
 Choice of schemes
 Transparency.

DISADVANTAGE OF MUTUAL FUND

 No control over Cost in the Hands of an Investor

 No tailor-made Portfolios
 Managing a Portfolio Funds
 Difficulty in selecting a Suitable Fund Scheme

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CHAPTER 3

HISTORY OF THE INDIAN MUTUAL FUND INDUSTRY

The mutual fund industry in India started in 1963 with the formation of Unit
Trust of India, at the initiative of the Government of India and Reserve Bank.
Though the growth was slow, but it accelerated from the year 1987 when non-
UTI players entered the Industry.

In the past decade, Indian mutual fund industry had seen a dramatic
improvement, both qualities wise as well as quantity wise. Before, the
monopoly of the market had seen an ending phase; the Assets Under
Management (AUM) was Rs67 billion. The private sector entry to the fund
family raised the Aim to Rs. 470 billion in March 1993 and till April 2004; it
reached the height if Rs. 1540 billion.

The Mutual Fund Industry is obviously growing at a tremendous space with

the mutual fund industry can be broadly put into four phases according to the
development of the sector. Each phase is briefly described as under.

First Phase – 1964-87

Unit Trust of India (UTI) was established on 1963 by an Act of Parliament by

the Reserve Bank of India and functioned under the Regulatory and
administrative control of the Reserve Bank of India. In 1978 UTI was de-
linked from the RBI and the Industrial Development Bank of India (IDBI)
took over the regulatory and administrative control in place of RBI. The first
scheme launched by UTI was Unit Scheme 1964. At the end of 1988 UTI had
Rs.6,700 crore of assets under management.

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Second Phase – 1987-1993 (Entry of Public Sector Funds)

1987 marked the entry of non- UTI, public sector mutual funds set up by
public sector banks and Life Insurance Corporation of India (LIC) and General
Insurance Corporation of India (GIC). SBI Mutual Fund was the first non-
UTI Mutual Fund established in June 1987 followed by Canbank Mutual Fund
(Dec 87), Punjab National Bank Mutual Fund (Aug 89), Indian Bank Mutual
Fund (Nov 89), Bank of India (Jun 90), Bank of Baroda Mutual Fund (Oct
92). LIC established its mutual fund in June 1989 while GIC had set up its
mutual fund in December 1990.At the end of 1993, the mutual fund industry
had assets under management of Rs.47,004 crores.

Third Phase – 1993-2003 (Entry of Private Sector Funds)

1993 was the year in which the first Mutual Fund Regulations came into
being, under which all mutual funds, except UTI were to be registered and
governed. The erstwhile Kothari Pioneer (now merged with Franklin
Templeton) was the first private sector mutual fund registered in July 1993.

The 1993 SEBI (Mutual Fund) Regulations were substituted by a more

comprehensive and revised Mutual Fund Regulations in 1996. The industry
now functions under the SEBI (Mutual Fund) Regulations 1996. As at the end
of January 2003, there were 33 mutual funds with total assets of Rs. 1,21,805
crores.

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Fourth Phase – since February 2003

In February 2003, following the repeal of the Unit Trust of India Act 1963
UTI was bifurcated into two separate entities. One is the Specified
Undertaking of the Unit Trust of India with assets under management of
Rs.29,835 crores as at the end of January 2003, representing broadly, the
assets of US 64 scheme, assured return and certain other schemes

The second is the UTI Mutual Fund Ltd, sponsored by SBI, PNB, BOB and
LIC. It is registered with SEBI and functions under the Mutual Fund
Regulations. consolidation and growth. As at the end of September, 2004,
there were 29 funds, which manage assets of Rs.153108 crores under 421
schemes.

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Structure of the Indian mutual fund industry

The Indian mutual fund industry is dominated by the Unit Trust of India and
which has a total corpus of Rs 700bn collected from more than 20 million
investors .The UTI has many fund /schemes in all categories i.e. equity,
balanced, income etc with some being open ended and some being closed
ended. The United Scheme 1964 commonly referred to as US64, which is a
balanced fund, is the biggest scheme with a corpus of about Rs 200bn URI
was floated by financial institution and is governed by a special act of the
parliament. Most of its investors believe that the UTI is government owned
and controlled, which, while legally incorrect, is true for all practical purposes.

The second largest categories of mutual funds are the ones floated by
nationalized banks. Can bank Asset management floated by Canara Bank and
SBI Funds Management floated by the State Bank of India are the largest of
these. GIC AMC floated by General Insurance Corporation and Jeevan Bima
Sahayog AMC floated by the LIC are some of the prominent ones. The
aggregate corpus of funds managed by this category of AMC’s is about Rs
150 billion

The third largest categories of the mutual funds are the once floated by the
private sector and by the foreign asset management companies. The largest of
these are Prudential ICICI AMC and Birla SUN LIFE AMC. The aggregate
corpus of the asset managed by this category of AMC s is in excess of Rs
250bn.

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Recent trends in the mutual fund industry:

The most important in the mutual fund industry is the aggressive expansion of
the foreign owned mutual fund companies and the decline of the companies
floated by the nationalized bank and smaller private sector players. Many
nationalized banks got into the mutual fund business in the early nineties and
go off to a good start due to the stock market boom prevailing then. These
banks did not really understand the mutual fund business and they just viewed
it as another kind of banking activity. Few hired specialized staff and
generally choose to transfer staff from the parent organization. Some schemes
had offered guaranteed returns and their patent organization had to bail out
these AMCs by paying large amount of money the difference between the
guaranteed and actual returns. The service level was also bad. Most of these
AMCs have not been able to retain staffs, float, and new schemes etc. and it is
doubtful whether barring a few expectations, they have serious plans of
continuing the activity in a major way.

The experience of some of the AMCs floated by private sector Indian

companies was also very similar. They quickly realized that the AMCs
business is a business, which makes money in the long term and requires deep
pocketed support in the intermediate years. Some have sold out to foreign
owned companies, some have merged with the others and there is general
restructuring going on.

The foreign owned companies have deep pockets and have come in here with
the expectation of a long haul. They can be credited with introducing many
new practices such as new product innovation, sharp improvement in the
service standards and disclosure, usage of technology, broker education etc. In
fact, they have forced the industry to upgrade itself and service levels of the
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organization like UTI have improved dramatically in the last few years in
response to the competition provided by these.

Future scenario:

The asset base will continue to grow at an annual rate of about 30 to 35% over
the next few years as investor’s shift their asset from banks and other
traditional avenues. Some of the older public and private sector players will
either close or be taken over.Out of ten public sectors players five will sell out,
close down or merge with strong players in three to four years. In the private
sector this trend has already started with two mergers and one takeover. Here
too some of them will down their shutter in the near future to come.

But this does not mean there is no room for other players. The market will
witness a flurry of new players entering the area. There will be a large number
of offers from various asset management companies in times to come. Some
big names like Fidelity, Principal and Old Mutual etc. are looking at Indian
market seriously.

The mutual fund industry is awaiting the derivation in India as this would
enable it to hedge its risk and this in turn would be reflected in its Net Asset
Value (NAV).

SEBI is working out the norms for enabling the existing mutual fund scheme
to trade in derivatives. Importantly, many market players have called on the
Regulator to initiate the process immediately, so that the mutual funds can
implement the changes that are required to trade in derivates.

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Role of SEBI in mutual fund:

In the year 1992 SEBI act was passed. The objectives of SEBI are – to protect
the interest of investors in securities, to promote the development of, and to
regulate the securities market. As far as mutual are concerned, SEBI
formulates policies and regulation the mutual fund to protect the interest of the
investors. SEBI notified regulation for mutual funds in 1993. Thereafter
mutual fund sponsored by private sector entities were allowed to enter the
capital market. The regulations were fully revised in 1996 and been amended.
Therefore, from time to time SEBI has also issued guidelines to the mutual
fund from time to time to protect the interest of the investors.

All mutual funds whether promoted by public sector or private sector entities
including those promoted by foreign entities are governed by the same set of
regulation. There is no distinction in regulatory requirement of the mutual
fund and all are subject to monitoring and inspecting by SEBI. The risks
associated with the scheme launched by mutual funds sponsored by these
entities are of similar type.

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CATEGORIES OF MUTUAL FUND:

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Mutual funds can be classified as follow :

Based on their structure:

 Open-ended funds: Investors can buy and sell the units from the fund,
at any point of time.
 Close-ended funds: These funds raise money from investors only once.
Therefore, after the offer period, fresh investments can not be made into the
fund. If the fund is listed on a stocks exchange the units can be traded like
stocks (E.g., Morgan Stanley Growth Fund). Recently, most of the New Fund
Offers of close-ended funds provided liquidity window on a periodic basis
such as monthly or weekly. Redemption of units can be made during specified
intervals. Therefore, such funds have relatively low liquidity.

Based on their investment objective:

Equity funds: These funds invest in equities and equity related instruments.
With fluctuating share prices, such funds show volatile performance, even
losses. However, short term fluctuations in the market, generally smoothens
out in the long term, thereby offering higher returns at relatively lower
volatility. At the same time, such funds can yield great capital appreciation as,
historically, equities have outperformed all asset classes in the long term.
Hence, investment in equity funds should be considered for a period of at least
3-5 years. It can be further classified as:

i) Index funds- In this case a key stock market index, like BSE Sensex or
Nifty is tracked. Their portfolio mirrors the benchmark index both in terms
of composition and individual stock weightages.

ii) Equity diversified funds- 100% of the capital is invested in equities

spreading across different sectors and stocks.

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iii|) Dividend yield funds- it is similar to the equity diversified funds except
that they invest in companies offering high dividend yields.

iv) Thematic funds- Invest 100% of the assets in sectors which are related
through some theme.
e.g. -An infrastructure fund invests in power, construction, cements sectors
etc.

v) Sector funds- Invest 100% of the capital in a specific sector. e.g. - A

banking sector fund will invest in banking stocks.

vi) ELSS- Equity Linked Saving Scheme provides tax benefit to the investors.

Balanced fund:

Their investment portfolio includes both debt and equity. As a result, on the
risk-return ladder, they fall between equity and debt funds. Balanced funds are
the ideal mutual funds vehicle for investors who prefer spreading their risk
across various instruments. Following are balanced funds classes:

i) Debt-oriented funds -Investment below 65% in equities.

ii) Equity-oriented funds -Invest at least 65% in equities, remaining in debt.

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Debt fund: They invest only in debt instruments, and are a good option for
investors averse to idea of taking risk associated with equities. Therefore, they
invest exclusively in fixed-income instruments like bonds, debentures,
Government of India securities; and money market instruments such as
certificates of deposit (CD), commercial paper (CP) and call money. Put your
money into any of these debt funds depending on your investment horizon and
needs.

i) Liquid funds- These funds invest 100% in money market instruments, a

large portion being invested in call money market.
ii) Gilt funds ST- They invest 100% of their portfolio in government
securities of and T-bills.
iii) Floating rate funds - Invest in short-term debt papers. Floaters invest in
debt instruments which have variable coupon rate.
iv) Arbitrage fund- They generate income through arbitrage opportunities
due to mispricing between cash market and derivatives market. Funds are
allocated to equities, derivatives and money markets. Higher proportion
(around 75%) is put in money markets, in the absence of arbitrage
opportunities.
v) Gilt funds LT- They invest 100% of their portfolio in long-term
government securities.
vi) Income funds LT- Typically, such funds invest a major portion of the
portfolio in long-term debt papers.
vii) MIPs- Monthly Income Plans have an exposure of 70%-90% to debt and
an exposure of 10%-30% to equities.
viii) FMPs- fixed monthly plans invest in debt papers whose maturity is in
line with that of the fund.

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INVESTMENT STRATEGIES:

1. Systematic Investment Plan: under this a fixed sum is invested each

month on a fixed date of a month. Payment is made through post dated
cheques or direct debit facilities. The investor gets fewer units when the NAV
is high and more units when the NAV is low. This is called as the benefit of
Rupee Cost Averaging (RCA).

2. Systematic Transfer Plan: under this an investor invest in debt oriented

fund and give instructions to transfer a fixed sum, at a fixed interval, to an
equity scheme of the same mutual fund.

3. Systematic Withdrawal Plan: if someone wishes to withdraw from a

mutual fund then he can withdraw a fixed amount each month.

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